18 March 2019
China's worsening balance of payments and fast money supply growth indicate that the renminbi will need to fall further. Photo: CNSA
China's worsening balance of payments and fast money supply growth indicate that the renminbi will need to fall further. Photo: CNSA

Why global investors may need more RMB hedging

Following the surprise victory of Donald Trump in the US presidential election, global investors are analyzing the possible impact on China’s trade with the United States. However, we would argue that market participants are missing a number of more pressing issues.

Ironically, Trump had opposed the US-led Trans-Pacific Partnership (TPP) trade agreement that had excluded China. The deal is now unlikely to be ratified. The vacuum created by the absence of a ‘one for all’ trade deal will allow China to seek faster adoption of bilateral trade deals with Asian and emerging market countries.

In the short term, investors should be considering the impact from three factors on local equity markets.

Firstly, China’s trade data had already been weakening in the run-up to the US election at a time when October data tends to be seasonally strong.

The trade numbers for October continued to miss expectations with dollar-denominated exports declining 7.3 percent year-on-year. Exports fell for the seventh consecutive month due to weak demand. According to the customs agency, new export orders fell and business confidence softened last month. In RMB terms, exports fell by 3.2 percent and imports grew by 3.2 percent.

Secondly, China’s Balance of Payments (BoP) data for the third quarter was very poor. Furthermore, forex reserves in October decreased US$45.7 billion to US$3.12 trillion amid a period of renewed weakness for China’s yuan. The reserves, last seen at this level in 2011, are now down US$870 billion from the peak in 2014.

While some of the decline is caused by valuation changes of the US dollar that rallied against many currencies in the China basket in October, the underlying BoP data demonstrated ongoing outflows caused by net FDI and tourism flows. In the lead up to Trump’s inauguration on January 20, we would expect the RMB’s decline to accelerate.

Thirdly, the Chinese economy’s inflation temperature is rising fast. While steel and coal prices have risen sharply demonstrating the unintended success of the government’s measures to close and restrain capacity, following damage to the crop in late 2015-16, garlic prices have risen on the mainland to such an extent they are almost as expensive as a hog (in per jin terms).

Unfortunately, garlic price change has had the distinction of causing a jump in inflation by itself in the past.

Indeed, it could be argued that China will start to not only tighten fiscal policy but also monetary policy. Chinese government bonds are vulnerable to the higher rate of inflation, in our view. Another gauge of inflation, narrow money supply (M1) is running close to 24 percent per annum.

A glance at China’s export price data suggests that the economy will be exporting inflation to the rest of the world from the beginning of 2017.

Equity investors should be careful not to be too distracted by the election of Trump as the 45th president of the US. US treasury bonds sold off sharply on Trump’s victory as economic policy is likely to be steered towards fiscal expansion financed by bigger deficits.

China’s bond market is also vulnerable to an inflation surprise around Chinese New Year. The fast rate of money supply hints that the RMB will need to decline further, particularly in the run-up to the January US presidential inauguration.

Global investors should own Chinese equities over local government bonds and hedge the RMB, in our view.

– Contact us at [email protected]


Chief Global Equity Strategist at Jefferies

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